Contributed by: KristineS, FreeTaxUSA Agent, Tax Pro
There’s just about nothing worse than opening your mailbox and finding a letter from the IRS. Your stomach flip-flops, and you get that sinking feeling of ‘now what?’
If the letter in your mailbox turns out to be a Notice CP2000, there’s still some good news because it’s not a bill yet. The CP2000 is only a proposal to change your tax return, and it states that prominently on the first page. But first let’s look at why you got the notice to begin with.
Why did I get Notice CP2000?
The IRS has a matching system for income. They compare what you enter on your tax return to what was reported to them by all the various payers. This includes your employer, your bank, your retirement plan administrator, the Social Security Administration, your brokerage firm, and so forth. The IRS is matching the W-2, 1099, and other forms they receive against the numbers reported on your tax return. If your tax return doesn’t match their records, they’ll likely send you Notice CP2000.
How come it took so long after I filed my return?
Individual tax returns are generally due by April 15th. However, many taxpayers file an extension for their tax returns, giving them until October 15th to file.
This means the IRS matching program can’t begin until after October 15th. That’s why the CP2000 is almost always related to the prior year’s tax return.
How do I know what they’re proposing is correct?
The CP2000 is typically several pages long, double-sided, and full of information that can be quite confusing. The general idea behind the notice is that according to the IRS matching system, you didn’t report all your income on your tax return, so they’re adding it now. On rare occasions, it might show overreported income as well.
Missing income is referred to as underreported income. When the IRS adds this income to your tax return, it may change your credits and deductions, increase your tax, and/or reduce your refund. Penalties and interest may also be applied. Either way, the IRS is proposing an increase and giving you 30 days to let them know you agree or disagree with their proposal.
What’s the process to respond?
First, on the last pages of the Notice, you’ll have the opportunity to respond by signing in agreement, either in part or full, or to disagree and explain why with supporting documentation.
Second, we recommend you look at a copy of the tax return in question. You can access your prior year return here if you don’t have your copy on hand. It’s easiest to look at the actual tax return you submitted while comparing it to the CP2000.
Below are two general examples to better understand what the CP2000 is showing. The IRS frequently updates the style of notices and letters, so yours may look different.
Example 1.
In this example, you see several columns across the page. The first and second columns show the name and address of the payer, Morgan Stanley. The third column shows what type of income was reported to the IRS. Here we see 1099-INT and 1099-DIV. The fourth and fifth columns show what was reported on the tax return ($0 in almost all instances) and what was reported to the IRS by the payer.
The difference between the two (shown in the sixth column) is the underreported income the IRS is adding to the tax return, which results in the proposed increase of tax due.
In many instances, the IRS is correct.
Here, $2,127 of bank interest and $2,580 in qualified dividends were left off the tax return; that’s very black and white. If you disagree, you’d have to prove the bank didn’t pay interest or dividends. If the proposed changes are correct, you’d sign in agreement with the IRS’s adjustment, return your signed agreement to the IRS, and pay the proposed amount due.
In some instances, however, the CP2000 doesn’t show the whole set of circumstances. If you can provide supporting documentation to show the full situation, this can reduce or eliminate the adjustment the IRS is proposing. In rare instances, it might even lead to a refund.
The most common example of this type of situation for underreported income is investment sales transactions not reported on the tax return from Form 1099-B.
Example 2.
In this example, $0 income was Shown on return by the taxpayer for investment sales at Morgan Stanley and Robinhood. However, the Reported by others column shows all the amounts reported to the IRS on Form 1099-B by the same companies. This is the underreported income.
The Difference column is what the IRS is adding as the proposed adjustment.
**Important note** The IRS generally does not include the basis, or original cost, for 1099-B investment transactions on the CP2000. Only the proceeds are reported in the Reported by others column, which can make it seem like the taxpayer experienced a 100% gain with no original cost.
The basis, or original cost, must be taken into consideration along with the proceeds to determine the correct gain or loss. In this instance, the taxpayer would need to amend the originally filed tax return and either add the missing sales transactions to an existing Schedule D or create the missing Schedule D showing all investment transactions.
The Schedule D will report an overall gain or loss. Even if it shows a gain, the amount will likely be substantially less than the gain the IRS is proposing. This is why it’s important to respond to the notice as quickly as possible -- you don’t want the IRS to add their proposed amount to your tax return!
When responding, it’s rarely necessary to send an entire amended return with your response. In fact, the CP2000 usually states not to file an amended return, but instead to send only the part of the return that was missing.
In the above example, if this were the only issue, the taxpayer would indicate their disagreement on the correct page of the Notice, include a copy of the completed Schedule D as their supporting documentation, and send both to the IRS as their response.
Help is available
FreeTaxUSA appreciates these are advanced concepts, which is why we offer advanced levels of support to assist our customers.
- Pro Support gives you access to advice from tax experts to help you prepare an accurate tax return before it’s filed.
- Audit Defense is offered before you file or receive a notice from the IRS or state. With this service, tax professionals can provide additional help in case an error is discovered after filing or you need to respond to the IRS or a state taxing authority.